Financial overconfidence leads to increased trading activity, higher risk taking, and less diversification. In a panel survey of online brokerage clients in the UK, we ask for stock market and ...portfolio expectations and derive several overconfidence measures from the responses. Overconfidence is identified in the sample in various forms. By matching survey data with participants’ transactions and portfolio holdings, we find an influence of overplacement on trading activity, of overprecision and overestimation on diversification, and of overprecision and overplacement on risk taking. We explore the evolution of overconfidence over time and identify a role of past success and hindsight on subsequent investor overconfidence in line with learning to be overconfident.
How do risk attitudes change after experiencing gains or losses? For the case of losses, Imas (Am Econ Rev 106:2086–2109, 2016) shows that subsequent risk-taking behavior depends on whether these ...losses have been realized or not. After a realized loss, individuals’ risk-taking decreases, whereas it increases after an unrealized (paper) loss. He refers to this asymmetry as the realization effect. In this study, we derive theoretical predictions for risk-taking after paper and realized gains, and for investment opportunities with different skewness. We experimentally test these predictions and, at the same time, replicate Imas’ original study. Independent of a prior gain or loss, we show that subsequent risk-taking is higher when outcomes remain unrealized. However, we find no evidence of a realization effect for non-positively skewed lotteries. While the first result suggests that the effect is more general, the second result reveals its boundary conditions.
Abstract
We test the proposition that investors’ ability to cope with financial losses is much better than they expect. In a panel survey of investors from a large bank in the UK, we ask for their ...subjective ratings of anticipated returns and experienced returns. The time period covered by the panel (2008–10) is one where investors experienced frequent losses and gains in their portfolios. This period offers a unique setting to evaluate investors’ hedonic experiences. We examine how the subjective ratings behave relative to expected portfolio returns and experienced portfolio returns. Loss aversion is strong for anticipated outcomes; investors are twice as sensitive to negative expected returns as to positive expected returns. However, when evaluating experienced returns, the effect diminishes by more than half and is well below commonly found loss aversion coefficients. This suggests that a large part of investors’ financial loss aversion results from an affective forecasting error.
In a panel survey of brokerage clients in the United Kingdom, participants mostly perceive their own portfolio as no more volatile than the market portfolio. Taking into account observed portfolio ...betas, this implies a belief in very low idiosyncratic portfolio volatility, which is even negative for a considerable fraction of the studied investor population. Possible explanations are extreme overconfidence in combination with a misunderstanding of how market and portfolio volatility are related. The identified bias contributes to underdiversification, as a belief in negative idiosyncratic volatility conceals the true benefits of diversification. In an experiment, we confirm the existence of a belief in negative volatility and rule out the underestimation of beta as an alternative explanation.
•Investors mostly perceive their own portfolio as no more volatile than the market portfolio.•This is shown to imply a belief in very low or even negative idiosyncratic portfolio volatility.•We argue that this belief is rooted in overconfidence and a misunderstanding of market risk.•The bias is related to diversification which has the main purpose to reduce idiosyncratic risk
To understand how real investors use their beliefs and preferences in investing decisions, we examine a panel survey of self-directed online investors at a UK bank. The survey asks for return ...expectations, risk expectations, and risk tolerance of these investors in three-month intervals between 2008 and 2010. We combine the survey data with investors’ actual trading data and portfolio holdings. We find that investor beliefs have little predictive power for immediate trading behavior. The exception is a positive effect of increases in return expectation on buying activity. Portfolio risk levels and changes are more systematically related to return and risk expectations. In line with financial theory, risk taking increases with return expectations and decreases with risk expectations. In response to their expectations, investors also adjust the riskiness of assets they trade.
Algorithm aversion in delegated investing Germann, Maximilian; Merkle, Christoph
Journal of business economics/Zeitschrift für Betriebswirtschaft,
11/2023, Letnik:
93, Številka:
9
Journal Article
Recenzirano
Odprti dostop
The tendency of humans to shy away from using algorithms—even when algorithms observably outperform their human counterpart—has been referred to as algorithm aversion. We conduct an experiment with ...young adults to test for algorithm aversion in financial decision making. Participants acting as investors can tie their incentives to either a human fund manager or an investment algorithm. We find no sign of algorithm aversion: participants care about returns, but do not have strong preferences which financial intermediary obtains these returns. Contrary to what has been suggested, participants are neither quicker to lose confidence in the algorithm after seeing it err. However, we find that participants’ inability to separate skill and luck when evaluating intermediaries slows down their migration to the algorithm.
Inconsistent Retirement Timing Merkle, Christoph; Schreibe, Philipp; Weber, Martin
The Journal of human resources,
05/2024, Letnik:
59, Številka:
3
Journal Article
Recenzirano
Odprti dostop
We study the effect of inconsistent time preferences on actual and planned retirement timing decisions in two independent data sets. Theory predicts that hyperbolic time preferences can lead to ...dynamically inconsistent retirement timing. In an online experiment with more than 2,000 participants, we find that time-inconsistent participants retire on average 1.75 years earlier than time-consistent participants do. The planned retirement age of nonretired participants decreases with age. This negative age effect is about twice as strong among time-inconsistent participants. The temptation of early retirement seems to rise in the final years of approaching retirement. Consequently, time-inconsistent participants have a higher probability of regretting their retirement decision. We find similar results for a representative household survey (German SAVE panel). Using smoking behavior and overdraft usage as time preference proxies, we confirm that time-inconsistent participants retire earlier and that nonretirees reduce their planned retirement age within the panel.
Abstract This paper examines whether biased income expectations due to overconfidence lead to higher levels of debt taking. We show suggestive evidence for a link between overconfidence and borrowing ...behavior in a representative survey of German households (German Socio‐Economic Panel–Innovation Sample GSOEP‐IS). This motivates a laboratory experiment to study causality behind these effects. In two experiments, participants can purchase goods by borrowing against their future income. We exogenously manipulate overconfidence about income expectations by letting income depend on relative performance in hard and easy quiz tasks. In the main experiment, we successfully generate biased income expectations and show that participants with higher income expectations initially borrow more. Overconfident participants scale back their consumption after income feedback. However, they remain in higher debt at the end of the experiment, which has real financial consequences. In a robustness experiment, we rule out that overborrowing is driven by low prices of goods. Even though the expected income manipulation works less well in this experiment, debt‐taking behavior is very similar and correlates with income expectations and overconfidence.
► In a new experimental design we test for the origin of overplacement. ► We distinguish between true overconfidence and a rational explanation. ► People hold beliefs inconsistent with rational ...information processing. ► Elicited belief distributions suggest the presence of a psychological bias.
The better-than-average effect describes the tendency of people to perceive their skills and virtues as being above average. We derive a new experimental paradigm to distinguish between two possible explanations for the effect, namely rational information processing and overconfidence. Experiment participants evaluate their relative position within the population by stating their complete belief distribution. This approach sidesteps recent methodology concerns associated with previous research. We find that people hold beliefs about their abilities in different domains and tasks which are inconsistent with rational information processing. Both on an aggregated and an individual level, they show considerable overplacement. We conclude that overconfidence is not only apparent overconfidence but rather the consequence of a psychological bias.
We conduct a controlled experiment with financial professionals to examine more directly whether value and momentum reflect risk factors or mispricing. By eliciting their risk perceptions and return ...expectations for company stocks, we identify what constitutes a risky investment from the point of investors. Contrary to the risk factor hypothesis, value and momentum stocks are regarded as less risky. However, other factors, such as size and beta, fall in line with their traditional interpretation as risk factors. Consistent with empirical findings, we observe higher return expectations for momentum stocks, raising questions on analysts believing in a risk–return trade-off.
•Controlled experiment with financial professionals to examine value and momentum.•Elicitation of risk perceptions and return expectations for company stocks.•Value and momentum stocks are regarded as safer contrary to view as risk factors.•Higher return expectations for momentum stocks but not for value stocks.
PDF
